Deflation Overview

This is a Deflation overview article I wrote that I originally had published on Ezine Articles.

Merriam Websters online resource states the definition of Deflation as "a contraction in the volume of available money or credit that results in a general decline in prices".

For many years, government policies have been introducing rules and regulations that have increased the available money and credit to allow for economic expansion.

In other words, inflation, the "increase of available money and credit" by definition.

For comparison, think of the tech bubble (tech crisis) of the late 1990's. Technology was advancing at such a rapid pace, that policies allowed for an almost unlimited supply of funds and loans to continue the cycle.

More money to research, produce and market meant higher prices and speculation which drove up the values of tech companies to the levels that to this day have not been reached again, over 8 years later.

Now look at the US housing bubble (housing crisis). Policies allowed for the ever increasing available money supply and credit advanced to a broad spectrum of buyers, many of which only qualified for loans due to lowered lending requirements, which led to higher and higher home prices and increased speculation.

As more people were able to purchase homes, the demand increased. As the available credit increased, the demand went even higher again. As the demand increased, so did the prices, inflation.

We can also see similarities in the past price of commodities, specifically Oil. Oil prices went higher and rose to approx. $145.00 per barrel in mid 2008. As the prices went higher and higher, there was a tremendous increase in specultaion, just as in the tech bubble and the housing bubble.

The tech stock bubble started deflating in February of 2000 and has been ever since.

The housing bubble started deflating in late 2005, early 2006 and is still deflating today, almost 3 years later.

Oil prices have gone from approx. $145.00 per barrel down to $50.00 per barrel in less than 4 months.

The current economic cycle is considered to be the "Financial bubble", or "Financial Crisis". The financial crisis started around 2007, almost 2 years after the housing bubble started to decline.

Why so long after the housing bubble peaked? Because as housing prices started to decline, investors and speculators were saying that housing was a good buy due to the drop in prices. Loans continued to be issued, at lower credit requirements to try and prop up housing on its way down.

Investors and speculators continued buying, lending and using leverage, to attempt to reap greedy profits in a battle they could not win.

Finally, after realizing housing prices were not going back up any time soon, houses started to be sold at losses, driving prices lower. Lending institutions, brokerage firms who were engaged in mortgage portfolios and hedge funds started to liquidate positions at losses, further driving down prices.

Remember the definition at the top of this article? "A contraction in the volume of available money or credit that results in a general decline in prices".

Tech stocks have been declining in price for 8 years now, in other words deflation.

Housing prices have been declining for about 2 years so far, deflation.

Financial stocks have been declining for just over 1 year now, deflation. Since the financials are what is needed to help expand the available money and credit, as they have gone lower, so have the rest of the markets.

The entire US stock market has been declining since 2007 and investors and financial "experts" are trying to assess the real value of assets that are declining in value on a daily basis. A pretty tough thing to accomplish.

So, as tech prices continue to decline, housing prices continue to decline, and financials continue to decline, so will the stock markets in general.

Just as prices went too high, they quite possibly will go too low below true values. Determining when that bottom occurs, is almost impossible.

Just as after housing prices started to deflate, investors kept buying and loans were still being granted to un-credit worthy people because people were saying housing was cheap, and would go back up soon. We now are hearing that stocks are cheap and would go back up soon.

One of the common characteristics of all bubbles before they start to deflate, is that there is a high amount of speculation that causes an unsustainable increase in prices. Speculation can also be seen by high amounts of optimism, above normal levels.

The reality is that the people saying this have a 50-50 chance of this happening. Stocks will either go up or down from here. If stocks go up, they will look brilliant. If stocks go down, they will look foolish.

It's true that the stock market has turned higher in the past before the economy turns higher, but it is also true that the markets tend to over extend themselves. This happens to the upside and the downside.




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